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Richard Levis, Global Real Estate Analyst, comments on the easing of UK commercial real estate returns and why this is likely to slow further this year

Lowers return expectations for 2016, decreasing from 8.7% to 6.6%

Forecasts 5.1% per annum return between 2016 and 2020

Performance likely to be strongest in regional offices and industrial assets

Richard Levis, Global Real Estate Analyst, says

“Total returns for UK real estate continued to lose momentum in the first quarter of this year, with the IPD UK Monthly Index showing All Property returns at 1.1%1 - their lowest quarterly reading since 2012. This weaker result was expected, with a slowing in momentum seen since last year. Transaction volumes in the first quarter were down by around a third in value terms year-on-year to £13.5bn.2 Although this was a large drop, the figure was still well above the £10.4bn quarterly average since 2000.

“Looking ahead, we do not expect rental growth to wholly offset the slower decline in yields. Our total return expectations are moderately lower than three months ago, at 6.6% for 2016, and averaging 5.1% per annum between 2016 and 2020. Risks we are monitoring in addition to Brexit include: the possible re-emergence of the Eurozone debt crisis; a faster rise in US interest rates than currently expected; and a sharper decline in Chinese economic output.”

“The high levels of financial market volatility seen at the beginning of this year have eased, but with economic growth having weakened, a general ‘risk-off’ mood has continued to prevail. Although there has been a partial recovery in the price of UK Real-Estate Investment Trusts (REITs) since February, the market remains subdued, with many REITS trading at a large discount to their net asset value. That may foreshadow further weakness in the direct property market.

“With property yields no longer falling as fast, maintaining income and generating rental growth will be drivers of performance in the near term. In this respect, we believe that the prospects in several property sectors are good. In our view, performance over the next five years is likely to be strongest in regional offices and industrial assets, and weakest in more volatile segments, including prime London offices and retail. Yields in these parts of the market have reached all-time lows and they appear vulnerable to occupier demand shocks or unexpected interest rate tightening.”

References

1 Investment Property Databank, May 2016

2 Propertydata.com

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